One of the ways for American investors to hold foreign shares of companies located in other countries is through something known as American Depository Receipts, or ADRs. Added to the expense of owning foreign stock are ADR fees, which are also known as ADR pass-through fees or ADR service fees. Let's take a look at what they are and how they work.
ADR Basics: Why Fees Exist
To explain why ADR fees exist, we need to first look at how ADRs work, how they are structured, and why banks create them.
The short, simplified version is that a commercial bank goes to a foreign stock market and buys shares of the foreign stock. It then brings these shares back to the United States, puts them into a sort of trust fund, issues certificates representing the stock that is now in the bank's vault, and sells these certificates on the stock market.
When the foreign company pays dividends in, say, pound sterling, Euros, Yen, or whatever other native currency it happens to utilize, the bank takes the money, converts it into U.S. dollars, and distributes it to the certificate owners.
This accomplishes several things. First, it allows the American investor to buy or sell the ADR in U.S. dollars. That's a lot more convenient than having to open a global trading account with an international brokerage firm. It also makes it possible, due to the economies of scale of the ADR itself, to acquire smaller investments in a cost-effective manner. If you were to buy shares on the foreign market directly, you're going to have to invest at least $10,000 to $100,000 in most cases to get it to be cost effective.
Second, the ADR lets you receive dividends in U.S. dollars. For a vast majority of people living in the United States, it doesn't do a lot of good to find yourself on the receiving end of Australian dollars, South Korean won, or Mexican pesos. You can't go down to your local McDonald's and use those to buy a Big Mac, nor can you pay your rent with it. As an added bonus, by converting the often millions upon millions of dollars received by the shares held in the ADR, the commercial bank can get far better translation rates, meaning more purchasing power ends up in your pocket in the end.
In exchange for all of this, the commercial bank is going to assess an ADR fee in most cases. ADR fees are relatively small and are often assessed on a per ADR basis. They cover the bank's expenses and lets them earn a reasonable profit on the service.
An Example of What An ADR Fee Might Look Like
Let's use Total, SE as an illustration. Total is one of the largest oil giants in the world. The French company has an ADR here in the United States that trades under ticker symbol TOT. Imagine you hold 1,000 of these ADR in your brokerage account.
Let's say the sponsoring bank divided the final U.S. dollars it had exchanged, paying out roughly $0.825238 per ADR. Those investors who were smart enough to sign up to take advantage of the treaty between the United States and France get the lower 15%, rather than 30%, dividend withholding rate. In this case, it would have been around $0.123795 per ADR. Finally, the bank charged half a cent, or $0.005, per ADR for facilitating the deal.
For your 1,000 ADR, your brokerage account statement might look something like this:
- 06/20/2020 Qualified Dividend = $825.30
- 06/20/2020 Foreign Tax Paid = -$123.80
- 06/20/2020 ADR Management Fee = -$5.00
In other words, you might have seen the $825.30 show up in your account, then immediately see a withdrawal of $123.80 for the French government and another $5.00 for the bank fees. This would have left you with a net cash deposit of $696.50. All in all, given the service the bank has provided, that's a wonderful trade-off that made your life as an investor much easier.
Beware of ADR Fee Calculations on Financial Websites
One downside of all of this is that a lot of financial websites, including the major financial portals, have different ways to deal with both the foreign taxes paid and the ADR fees. When you look at a stock quote for a U.S. company—General Electric or Coca-Cola would be good examples—the dividend rate and dividend yield are shown in pre-tax figures.
On the other hand, some programmers grab the net ADR distribution, which is an after-tax figure, making it appear as if the stock has a much lower dividend yield than it does; an apples to oranges comparison. This has some interesting consequences. Nestle, one of the biggest and oldest blue-chip stocks in the world, is almost always treated this way, causing a lot of American investors who would do well to consider having it in their long-term family portfolio to look elsewhere, as it appears artificially expensive.